Clash of the Titans: Royal Gold vs. Franco-Nevada

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Includes: FNV, KGC, RGLD, TGB
by: Hyperinflation

While Royal Gold (NASDAQ:RGLD) and Franco-Nevada (FNNVF.PK) are the two gold royalty juggernauts, each has gone about acquiring growth in different ways. But the main focus of this article is to help determine which will end up being the better investment. The following will provide a brief overview of both these companies transformation that has transpired following the crash of 2008, at which time both companies began pursuing aggressive growth. The following are the transactions post '08.

Franco-Nevada

Afaho (Subika) - Franco closed this deal during the heart of the '08 crash from Newmont, paying $58 million for a 2% NSR on Newmont's Ghana property. The royalty becomes payable after 1.2m ounces have been produced, which will be towards the very end of 2011, start of 2012. While over 50% of total production have been within that which falls on Franco's royalty or approx. 250k annually (with the potential to optimize operations in the years ahead). Annual attr production will amount to about 5k ounces annually.

Gold Quarry- Franco-Nevada acquired this royalty soon following the crash from Newmont Mining. This royalty is a 7.29% NSR or approx 12k attributable ounces for 103m.

Palmarejo - I consider this acquisition the start of Franco's transformation into the company it is today. Following the financial crisis, many mining companies were in finacial distress, allowing companies such as Franco to acquire extremely high quality royalties at bargain basement prices. Franco acquired a 50% gold stream from Coeur d'Alene for the LOM in exchange for 84.9 million upfront + an on-going purchase price per ounce of $400. The Palmarejo property has since proven to be a much more valuable asset than originally anticipated. Following this acquisition, Palmarejo has realized tremendous upside potential and will continue to do so going forward. Intially Palmarejo was projected to produce 90k of gold annually, which has since been increased to between 110,000-120,000 annually (55-60k att to Franco). The real kicker is regarding additional high quality deposits, notably the Guadalupe deposit, which is looking like it will be an 80-90k oz producing mine. Additionally, promising results from another possible deposit, Tuscon-Chapotillo, could further add to production capacity in the years ahead. Summing it up Franco paid just 85m in exchange for (approximately 90-100k attributable ounces annually by 2013-2014) + any additional upside potential that has yet to be recognized.

Tasiast & Detour Lake- Franco initially made investments in these two mining operations, receiving a 2% NSR on both while Franco was still part of Newmont. Following the Kinross (NYSE:KGC) buyout of Red Back Mining in 2010, Kinross soon announced it could optimize Tasiast to produce 1.5m oz annually by 2015 or 30k attributable to Franco(nearly 3x that initially estimated). Detour Lake has also seen production guidance increase substancially, now projected to be between 650-700k with on-going studies to determine the economic viability of a mill expansion which would increase annual production by approx 50% or 1m oz annually. Using the base case scenario these two royalties add approx 42-50k attributable oz (@ no cost). In other words Franco paid a small amount earlier, only to now realize the vast upside on these two projects.

Prosperity - In 2010, Franco signed an agreement with Taseko (NYSEMKT:TGB) to acquire a 22% stream on the high quality Prosperity Project in Canada for 350m in cash up front plus on-going per ounce cost of $400/oz. 22% equates to approx. 60-65k ounces annually based on the PEA. This, however, has yet to materialize as it failed to get the neccessary permitting due to environmental concerns among other things. Taseko has recently resubmitted the paperwork for the neccessary permitting which addresses all the concerns outlined in the first rejection.

Gold Wheaton: Franco-Nevada closed its acquisition in early 2011 of peer Gold Wheaton, acquiring 3 gold streams and 2 gold and PGM streams for approx 1B, increasing Franco's attributable production another 115k-130k gold equivalent ounces at an ongoing per ouce cost of $400/oz.

2008 - Today

Spent 1.245B for approx an increase of 255,000 gold equivalent ounces by 2015.

Potential - Spent 1.6B for approx an increase of 315,000 gold equivalent ounces by 2015-2016.

Royal Gold

Andacallo - Like Franco, Royal Gold was able to take advantage of distressed companies with great assets such as Tech Conmico's Andacallo property in Chile. In exchange for a 75% streaming interest on all gold produced for the LOM, Royal Gold paid Tech $218m @$0 per on-going ounce purchased. Annual att production is estimated to be 40,000 ounces annually for great than 20 years. Current studies are on-going to optimize Tech's mill, increasing annual production and reducing he currently estimated mine life.

International Royalty Company - Soon after the Andacallo Transaction, Royal Gold outbid Franco-Nevada for smaller rival competitor International Royalty Company. Royal Gold paid total considerations of $750m ( stock + cash). Royal Gold acquired a quality portfolio of assets highlighted by a 4.23% NSR on one the up and coming world class gold mines in Pascua-Lama, located on the Chilean/Argentinian border. Other notable mentions in IRC's portfolio include a 2.7% NSR on Voisey;s Bay ( 18-20k gold equivalent ounces), 1.5% NSR on Las Cruces ( ramp up to approx 12-14k+ gold equivalent att ounces). Other currently producing royalties from this portfolio add an additional 10-12k ounces to att production while also adding numerous royalties ro Royal Golds pipeline. In other words, this $750m increased immediate gold equivalent production growth of approx 40-42,000 ounces + 30-35,000 ounces from Pascua-Lama + ???? in pipeline growth. Royal Gold later increased its Pascua-Lama NSR to 5.23% or 40,000 att ounces.

Mt. Milligan - Royal Gold acquired what I consider to be the best royalty/stream purchase agreement made by the company following the Andacallo transaction. For total consideration of $312,000,000, Royal Gold now has a 25% streaming interest at Thoman Creeks, Mt Milligan project estimated to produce 265,000 ounces for the first five years and 200,000 thereafter. Royal Gold will receive 60-62,000 att ounces annually for the first five years @ $400/oz , falling back to 50,000 att ounces thereafter at $450/oz.

Spent: 1.28B-1.32B for a production increase of approx 180,000 gold equivalent ounces + numerous additions to its royalty pipeline.

Applying Discounted Cash Flow analysis to both these companies using an 8% discount rate, 3% long term growth, gold price deck of $1,500/oz yields the following:

Franco-Nevada: $69.50 implies an undervaluation of 85.44%.

Royal Gold: $111.20 or an undervaluation of 94.44%.

Assuming Prosperity does get permitted, Franco's valuation would jump to $74.50 or an undervalution of 96%.

As of now Royal Gold looks slightly more attractive but things could easily reverse should prosperity receive permitting. One also has to take into consideration each companies non-gold royalties as copper and other base metals make up most of Royal Gold's non gold revenue while oil and gas account for approx 10% of Franco's portfolio.

Disclosure: I am long RGLD, FNNVF.PK.